The Limited Liability Company (LLC) is a flexible legal entity that allows taxpayers to elect how they want to account for their state and federal tax liabilities. Unfortunately many taxpayers do not understand issues surrounding whether they should use the LLC and in what form to achieve their tax and asset protection goals. This article will briefly discuss one issue in this analysis, namely employment or payroll tax liabilities.
The IRS regards a single member LLC (i.e, a LLC owned by one individual or entity) as not being a separate taxable entity distinct from the owner, unless the owner opts to have the LLC treated as a corporation for tax purposes. As a disregarded entity the sole owner of the LLC can simply account for the profits and losses of the LLC on the taxpayer’s personal tax returns (on the taxpayer’s Schedule C).
It is the sole owner of a single member LLC that is personally responsible for employment taxes related to the LLC’s employees. The IRS has the ability to impose a lien or levy or seize the sole owner’s personal assets if the LLC’s employment taxes are not paid, but the IRS cannot levy or seize the LLC’s assets to satisfy this type of liability. This is true regardless of whether the sole owner elected to use his or her name and social security number for the LLC tax reporting or if the sole owner elected to use the LLC name and a separate taxpayer identification number for the LLC tax reporting.
The result for the multi-member LLC (i.e., a LLC owned by more than one individual or entity) may be different depending on the applicable state law. If the state law provides that members of LLC’s are not liable for LLC debts then the IRS’s recourse with regard to the LLC’s unpaid employment taxes lies with the LLC and not with the member owner.
For the most part businesses are started with the aim of making a profit. The thought of incurring a loss is often not planned for in the business formation or start up process. As such, this type of employment tax issue typically does not arise until after the LLC is facing financial difficulties. In these cases the LLC may be unable to meet its state and federal employment tax obligations. If the LLC employment taxes are not timely remitted, the question is whether the state and federal government may collect the employment tax liability from the LLC or the LLC owner or owners.
This issue is most important for LLC’s that employ a number of employees and/or that employ highly paid service employees. In these cases the LLC owners with little or no assets and no expectation of having significant assets or whose only significant assets are those used in their trade or business (e.g., a mechanic whose only assets are his or her tools) may prefer that the IRS pursue him or her individually for the LLC’s employment tax obligations. On the other hand, the financially well off LLC owner may prefer that the IRS only be able to pursue the LLC for the LLC’s employment tax liabilities.
Given this dichotomy it may make sense for single member LLC owners to convert their single member LLCs into multi-member LLCs or to elect to have the LLC be taxed as a corporation once the LLC has achieved some measure of financial success. Of course, the business owner must also consider other tax factors, such as the trust fund recovery penalty and the role of self-employment taxes.